A Deep Look at LINN Energy's Fourth-Quarter Results

LINN Energy (NASDAQ: LINE) and LinnCo (NASDAQ: LNCO) reported strong results before the market opened today. Distributable cash flow was stronger than expected, while production exceeded the lower end of the company's guidance range despite the impact from severe winter weather. Let's take a deeper look at the most important numbers LINN Energy reported for this past quarter.

The numbers that matterLINN Energy's oil and gas production averaged 889 million cubic feet of natural gas equivalent per day, or MMcfe/d, in the fourth quarter. However, that number included 44 MMcfe/d from the LinnCo-led deal to buy Berry Petroleum, which closed near the end of the quarter. Backing that out, the company produced an average of 845 MMcfe/d, which was at the lower end of the company's guidance range of 840-860 MMcfe/d. Persistently severe winter weather affected production during the quarter, which makes even hitting the lower end of the guidance a success.

Another important number worth watching was Berry Petroleum's production in the fourth quarter. Before closing its deal with LinnCo, Berry Petroleum was guiding for fourth-quarter production of 44,000 barrels of oil equivalent per day, or BOE/d. LINN Energy noted that Berry Petroleum's fourth-quarter production was actually slightly higher at 45,000 BOE/d. That growth also represented a 9% jump from the prior quarter.

Finally, and most impressively, was the $202 million that LINN Energy put up for distributable cash flow. What made that impressive was that the company only distributed $170.5 million to unit holders, which left an excess of $31.5 million. LINN Energy had guided for cash flow in excess of its distribution of 5%-10% on the quarter, which it easily exceeded. For a company that struggled to cover its distribution earlier in 2013, this is a welcome situation.

One area to watchProduction guidance for 2014 looks a little light. The company expects first-quarter production to average between 1,070 and 1,100 MMcfe/d. However, for the full-year the company doesn't see much if any growth as the guidance range is 1,070 to 1,140 MMcfe/d. This guidance range does include ethane rejection of 22 MMcfe/d.

Photo credit: LINN Energy.

This is something that needs to be watched due to the fact that LINN Energy also announced a capital budget of $1.55 billion for oil and gas projects. That's 11% less than the combined companies spent in 2013, and it would appear that most of that money would be used to offset production declines, not grow production.

A quarter of that money will be spent in the Permian Basin, which holds both promise and uncertainty at the moment. Part of the promise is in the fact that the company believes its acreage has horizontal potential in the Wolfcamp shale. The company is participating with Diamondback Energy (NASDAQ: FANG) on a nonoperated well. We should expect the results of the Diamondback Energy well in the first quarter.

In addition, LINN Energy is looking to drill 10 operated wells in the second quarter, targeting the Wolfcamp. Those wells add uncertainty and risk. Adding to the uncertainty is the fact that the company announced strategic alternatives for this Midland Basin portion of its Permian Basin assets. The company could sell, trade, or partner on these assets. While there appears to be real value here, as Diamondback Energy's recent purchases of acreage in the area suggest, the extent of that value and how LINN Energy intends to develop it remains to be seen. Still, there is exciting upside potential, which could have a significant positive impact of 2014 guidance.

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I think that pending swap, of high decline assets for properties more suited to an MLP, is what management is waiting for in terms of improving cash flow and returning to distribution growth. Of course they can't include something that hasn't happened in expectations, nor further acquisitions, but if you read between the lines this morning on the call, they feel really good about pulling that off, and it's a reason they cited for dumping the capex budget down, that they don't really need to goose coverage.

I hate to see distributions stay static though, sends the wrong signal. I think they should have bumped it a nickel, just as a show of good faith. They seem to have the room.

Yeah, I agree with you on that. I would have liked to see a distribution boost, but it just seems like we'll have to wait until they finish the review. The CC was pretty good and they made it a point to say they if they put back the $250M in capex the excess cash flow would have increased.

I also liked that the company sees the Permian Basin assets as a bank to do future deals. That worked well for Denbury Resources last year. It means no more capital raises for a while.

"I hate to see distributions stay static though, sends the wrong signal. I think they should have bumped it a nickel, just as a show of good faith. They seem to have the room."

I agree completely. This is an income security to most holders. Static distributions in a rising rate environment mean capital losses. The MLPs with growth potential will be better bets, and this flat forecast wasn't greeted with much patience. A token raise would have tempered the response of the show-me-the-money crowd.

The other thing that can't help is that there was an overall tenor that the Permian assets will be divested in some form to fuel other slower decline acquisitions. That certainly makes sense given LINN's asset base and experience. However, that decision to not develop some pretty hot acreage in-house may have triggered other ex-Berry holders to monetize their gains and move on to greener, less conservative pastures.

I'm not disputing the decision, although I'm not crazy about the unfocused language of the presser either. That breeds some uncertainty in its own right. I'm just saying that the mindset of some the some inherited Berry holders is not necessarily aligned with the average LINE or LNCO holder. That may be fueling the negative reaction as well.